Looking for a better consumer price index

Financial Express, June 20, 2006

Many media reports claim that consumers perceive inflation in excess

of the reported 4.7 per cent. This questions the integrity of

government statistics. In a remarkable recent episode, trade unions

have objected to the ILO that workers mistrust the revised CPI for

Industrial Workers (base year = 2001). Steps much be urgently taken to

create a trasnparent weekly CPI that is released with a lag of no

worse than a fortnight.

Currently, for watching inflation in India we have the choice of using

the CPI or the WPI. The pros and cons of the two are as follows.

Frequency: The WPI is released weekly, while the CPI is monthly.

Delays: As an example, as of today (17 June), the most recent

available WPI pertains to June 3, 2006 but the most recent available

CPI pertains to April 2006.

Choice of commodities and weights: The WPI reflects neither producer

prices nor consumer prices. It suffers from questionable choice of

commodities and weights. Adequate care has not been taken in

accurately defining the grade and physical specifications of

commodities. The CPI has a fundamentally superior methodological

foundation, for a household survey is utilised to find out the

consumption of a "typical" household, and this drives the choice of

commodities and weights.

Transparency: Data about the series going into the WPI is released

into the public domain. The CPI is much more non-transparent. When the

government releases a GDP number, households do not feel they have an

independent view about GDP. But when it comes to inflation, everyone

who shops has a view about the "true" inflation. The non-transparency

of CPI has encouraged mistrust of the CPI and conspiracy theories

about manipulation of data by the government.

So while the CPI fundamentally makes more sense than the WPI, the

usefulness of the CPI has been radically undermined owing to low

frequency, high delays and non-transparency. As a consequence, the

"headline inflation number", which is widely followed in the press,

has become the WPI.

A major achievement of macro policy in India in the last decade has

been a decline of inflation to sub-5% levels. A healthy feature of

Indian politics is that there is an uproar when inflation goes up;

this acts as a check against a government that might seek to impose an

inflation tax upon bondholders. However, inflation in India remains at

very high rates by world standards, where well run central banks

target inflation rates like 2 to 2.5%. India's finishing stretch, in

going from inflation of roughly 4% to roughly 2-2.5%, strongly

requires better measurement of inflation, for we would now be dealing

with small and subtle changes in inflation.

A committee headed by Planning Commission member Abhijit Sen has been

given the task of constructing a Producer Price Index (PPI) for

India. However, it is equally important to transform the CPI. The CPI

needs to shift to a weekly frequency, with a lag of no greater than

one fortnight. It needs a top quality methodological foundation in

terms of a household survey which is no more than 3 years old, where

the full survey database is released into the public domain, so that

there are no accusations about fudging weights or

commodities. Finally, every piece of price information that goes into

the CPI needs to be released into the public domain. This needs to be

done for historical data also, so as to enable innovative applications

of this information, and improve the trustworthiness of the CPI.

Once inflation measurement is improved, two major developments can

take place.

The first is the issuance of inflation indexed bonds. Perhaps a

quarter of the bond issuance of the GOI needs to be shifted to

inflation indexed bonds. The reason for this is two-fold. First,

households who seek to plan for old age without uncertainty about

inflation should be able to do so. Second, the secondary market

trading of inflation-indexed bonds reveals the market's perception

about expected inflation, a key ingredient that goes into monetary

policy formulation.

The second major development would be a much more modern monetary

policy that explicitly links up developments on inflation to the

short-term interest rate setting of the central banks. At present, it

is impossible for RBI to be particularly scientific about monetary

policy, for the foundation of that (inflation) is not properly



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